The agreement between Abu Dhabi-based TAQA and Turkey's state-run power company EUAS marks the biggest Arab investment in the Turkish energy sector, a senior energy ministry official told AFP.
"This is a very serious investment, a significant investment," Turkish Energy Minister Taner Yildiz said at the signing ceremony in Ankara.
"This is the second-biggest investment made in Turkey after the two nuclear power plant projects," he added.
The government plans to build three nuclear power plants in hopes of preventing a possible energy shortage and reducing dependence on foreign energy supplies.
Turkey struck a deal with Russia in 2010 to build the country's first power plant at Akkuyu in the southern Mersin province.
Ankara is officially in negotiations with China, Japan, South Korea and Canada to build the second nuclear reactor.
With the latest agreement, the coal reserves at Afsin-Elbistan basin in southern Turkey will be put to use for electricity production.
"This agreement gives our company an exclusive right to negotiate with the Turkish government on this project for the next six months," an official from TAQA told AFP.
The negotiations will lead to the signing of a "host government agreement" in the second quarter of 2013, establishing more detailed terms, he added.
TAQA and Turkey's EUAS have been selected as the government-related entities responsible for implementing the project.
Under the intergovernmental agreement, the project partners will modernize and expand the existing 1,400 MW Plant B and develop several new power plants and associated mines in sectors C, D, E and G of the Afsin-Elbistan region.
And preparatory work on Plant B and the feasibility study for the planned 1,440 MW Plant C and associated mine development will start immediately.
The Afsin-Elbistan basin where two thermic power plants are already in operation has the potential to power new plants with a total installed capacity of 8,200 megawatts.
The region contains 4.4 billion tons of coal reserves, which account for approximately 40 percent of Turkey's lignite resources.
Turkey places priority on the development of its lignite in an attempt to reduce its dependence on imports of natural gas.
With a new power plant that will be established in this region, Turkey is hoping to cut nearly $1.2 billion worth of natural gas imports, which account for a large part of the country's current account deficit.
Turkey, which produces most of its electricity from natural gas, is heavily dependent on imported energy.
And it is under severe pressure from its Western allies to reduce imports of gas from neighboring Iran owing to Tehran's disputed nuclear program.
Iran is Turkey's second-biggest natural gas supplier after Russia.
But government officials repeatedly said that Turkey would keep buying natural gas from Iran which supplies 18-20 percent of the gas it consumes.